Microeconomic tools Eleni ILIOPULOS PSE, University of Paris 1
Lecture 3
E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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This lecture
Aim of this Lecture: Develop a simple formal framework to think about trade barriers understand di¤erent types of trade barriers Structure: 1. 2. 3. 4.
(Very) basic supply and demand analysis Open economy supply and demand analysis Introducing an MFN tari¤ into the framework Di¤erent types of trade barriers
E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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How is trade a¤ected by trade barriers (e.g. tari¤s)?
Economists use a simple framework to see the main trade-o¤s (this lecture) make it more ‘realistic’later (Chapter 6) Simplifying assumptions: perfect competition constant returns to scale (CRS) technology
E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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Supply and demand Demand
Recall your …rst Micro course! Demand curve: at which price do you buy a good? as long as p mu Demand curve: plots your marginal utility (mu) when price is p* you buy c* Market demand: aggregates over all individual demand curves
E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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Supply and demand Supply
Supply curve: …rms face increasing marginal costs (mc) …rms produce as long as p mc for p* …rms produce c* Market supply: aggregates over all individual supply curves Attention: increasing mc is a strong assumption!
E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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Welfare Welfare analysis
- Di¤erence between p and mu is ‘utility gain’ ! welfare - when price falls: consumers better o¤ 2 parts: (A) pay less for units consumed at old price; area A (B) gain surplus on the new units consumed; area B. Consumer surplus measures the amount a consumer gains from a purchase by the di¤erence between the price he actually pays and the price he would have been willing to pay. E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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Welfare
Producer Surplus: - Di¤erence between p and mc is what …rms gain on an additional unit - when price rises: …rms better o¤ 2 parts: (A) get more money for units produced at old price; area A (B) gain surplus from sales of additional units; area B
E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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Open economy
Next: Open Economy Supply & Demand Analysis Import Demand Curve: - how much would you (a nation) import for any given p ? - assumption: imports and domestic production perfect substitutes ! gap between your consumption and your production: your imports
E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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Supply and demand in open economy
E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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Open economy, S vs D
Constructing the import demand curve MD: - MD stands for import demand - for P* home production = home consumption ! zero imports - P’P* ! less consumption; more production ! Foreign exports! - Exports for P’: Z’-C’=X’ Note: Import supply (to Home) is the same as export demand Foreign is facing (here we only have 2 countries)
E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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Foreign country
Welfare of Foreign: - consider higher price: P’!P” - consumers loose A+B; producers win A+B+C+D+E - Net gain of Foreign shown by MS curve: C+D+E=D+F Now we can combine MD and MS to …nd the equilibrium! Think: what are the main equilibrium objects we want to know?
E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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MD/MS
The MD/MS diagram: - Very simple - Intersection of MS and MD is the equilibrium - Equilibrium price and imports easy to see But: production and consumption? ! Just combine with the open economy S&D diagram!
E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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Open economy, S vs D
E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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Open economy, S vs D Exercise (in class)
1. Draw three graphs: Home S&D in the left graph and the Home MD curve in the second graph. (small check: how would the Home XS curve look like?) Consider the case where Home is importing in equilibrium. 2. Draw Foreign S&D curves (right graph) and the corresponding MS curve that are consistent with Home importing and Foreign exporting in equilibrium! For step 2: pay attention to the intercepts of the MS and MD curve and their intersection (the equilibrium). Make sure that the equilibrium exports in the MS/MD diagram are equal to the exports on the Foreign S&D diagram and the imports in the Home S&D diagram. (otherwise this is not an equilibrium.) What would you have to do di¤erently in the case where Home exports? How does this relate to the prices in autarky (the prices countries have when no trade is possible)? E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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Introducing tari¤s
So far: free trade How would a tari¤ look in the MS/MD diagram? Tari¤ drives a wedge between the price the producer gets ‘Border Price’and the price the consumer pays ‘Domestic Price’ Most Favoured Nation Tari¤ The di¤erence goes to the Home government
E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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Introducing MFN tari¤s
MFN tari¤: - European integration: preferential liberalization (tari¤ cuts only for European partners) - MFN tari¤ ‘Most Favored Nation’: the same tari¤ for all trade partners. - we shall see the preferential case later - for now take Foreign as a group of other countries and add a tari¤ Introducing a tari¤: - tari¤: T Euro per unit have to be paid for each import - now the border price di¤ers from the domestic price - border price + T = domestic price
E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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Introducing MFN tari¤s into MS/MD
E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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Introducing MFN tari¤s into MS/MD
A tari¤ in the MD/MS diagram: - note: border price 6= domestic price ! MD shifts up by T New equilibrium: - domestic price increases (but by less than T) - border price decreases (Foreign gets less Euro per unit) - imports decrease - if you add an open economy S&D diagram, you’ll see that domestic consumption falls, domestic production rises, foreign consumption rises, foreign production falls
E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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Welfare
Home welfare e¤ects: - loss of surplus -A-C - tari¤ revenues A+B overall e¤ect: B-C Foreign welfare e¤ects: - loss of surplus: -B-D ! Foreign loses -B-D World welfare: - loss of -C-D - home ‘takes’B from Foreign
E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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MNF tari¤s
Distributional e¤ects of a tari¤: cui bono? - MD/MS represents the surplus of ‘a country’ - Trade restrictions are political decisions ! who bene…ts, who looses within a country matters! Graph (next slide) shows: - Home consumers lose E+C2+A+C1; Home producers gain E; Home tari¤ revenue rises by A+B - net change = B-C2+-C1 (this equals B-C in left panel).
E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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Distribution
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Microeconomics
Lecture 3
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Types of tari¤s
Useful categorization: Ask: who gets the rents? - DCR (domestically captured rents) e.g. tari¤, import licence - FCR (foreign captured rents), price undertakings, export taxes - Frictional (no rents since barriers involve real costs of importing/exporting), e.g. Swedish wipers on headlights
E. ILIOPULOS (PSE, University of Paris 1)
Microeconomics
Lecture 3
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Types of tari¤s
Net Home welfare changes: DCR = B-C FCR = -A-C Frictional = -A-C Net Foreign welfare changes: DCR = -B-D FCR = +A-D Frictional = -B-D Note: foreign may gain from FCR.
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Microeconomics
Lecture 3
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